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Demonetisation: The Lies The Government Weaves As It Abandons Reason -Prabhat Patnaik
-TheCitizen.in

NEW DELHI: So many lies are being spread by the government which is currently busy wrecking the Indian economy in the manner of a bull in a china shop; so many spurious economic arguments are being trotted out by it, that one has to be extremely vigilant not to be swept away by this tide of unreason.

In the current article, and the two subsequent ones to follow, I propose to examine some of the more persistent assertions that are being made by government spokesmen.

The most persistent assertion of course is that demonetisation is a measure against “black money”. In an earlier article I had pointed out that the term “black money” was a misnomer, that it was not a “stock” but a “flow”, that it refers not to stacks of currency notes hidden in pillowcases, but to a whole set of undeclared activities, some illegal, others legal but undeclared nonetheless in order to avoid payment of taxes.

These activities, like all others, are carried out with the help of money, in this case largely in the form of currency, i,e. the flow of such activities requires a stock of currency, but disabling a part of this stock would not terminate these activities as long they remained profitable.

Let me illustrate this point with some figures. The maximum amount of currency which the government hopes to disable in the “black economy” through its demonetisation move is reportedly Rs. 3.5 lakh crores. Indeed a former governor of the Reserve Bank of India, D. Subbarao, a supporter of the demonetisation move, has also mentioned this as the maximum amount that can be rendered worthless in the “black economy”. The size of the “black economy” however, according to a World Bank study, is close to a quarter of the “white economy”, i.e. roughly around 35 lakh crores. Others would put the figure much higher, which would actually strengthen the argument that follows, but let us accept this lower figure.

Now, the share of profits in the “black economy”, again on a conservative basis, would be half of the total income generated, i.e. 17.5 lakh crores. The magnitude of the disabled stock of currency therefore would amount to no more than 20 percent of the annual flow of profits in the “black economy”. Were it all to be offset via a reduction of profits, then the profit rate in this economy would merely fall from, say 25 percent (again to take deliberately an extremely conservative figure) to 20 percent. To imagine that this minor dip would constitute a blow against the “black economy” is absurd.

But the question may be raised: even if such disabling of cash would be a small matter relative to this sector’s profits, which would not discourage “black activities”, nonetheless cash would be required for carrying on these activities as before; would not the sheer loss of this cash therefore create problems for the operations of the “black economy”? And indeed herein lies the rub.

As long as “black activities” remain profitable, which they would despite the once-and-for-all dip in the profit rate just mentioned, this loss of cash owing to demonetisation (and let us assume, for argument’s sake, that that there is such a loss as anticipated by the government), would only mean, that for carrying on these activities, the “black economy” would now demand fresh cash.

This would raise the interest rate, unless the Reserve bank of India increases the supply of currency to make good exactly what has been lost by the “black economy”. Such a rise in the interest rate would simply suck out cash from the “white economy” to finance the working of the “black economy”; and this sucking out can only be at the expense of the petty, “informal” sector which is both extremely cash-dependent, and is so precariously placed that it is vulnerable to a jack-up in interest rates.

In short, demonetisation, far from being an attack on the “black economy”, would in effect turn out to be an attack on the vulnerable “informal” segment of the “white economy”.

And this is so because of the immanent logic of the system, which the government, on a charitable interpretation, does not understand.

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